BNR.US
Burning Rock faces delisting threat

The cancer-screening products maker is in danger of being forcibly delisted due to its sinking stock price, as income from its former top revenue source tumbles amid an industry crackdown

Key Takeaways:

  • Burning Rock announced its shares could be delisted due to prolonged trading below the required $1 threshold
  • The cancer detection specialist’s former biggest revenue source tumbled 40.6% in the third quarter amid an industry crackdown, spotlighting a major risk for Chinese companies

  

By Doug Young

Its name is Burning Rock Biotech Ltd. (BNR.US), but these days the maker of cancer screening-products might be better named “Burning Cash.”

Its dwindling cash pile as the company continues to lose money is weighing heavily on investors’ minds these days, pushing its formerly high-flying stock below the $1 level since Nov. 10, or for the last two months. That prompted the Nasdaq, where Burning Rock’s shares are traded, to inform the company last week that it was in danger of being delisted for non-compliance with rules requiring its price to be above $1.

It’s always possible Burning Rock’s shares could rally back above the $1 mark on their own, especially if it can return to revenue growth following sharp declines in its latest reporting quarter. There’s also the possibility the company will conduct a reverse share split, which is the most common way to bring a price back above the $1 level.

But another possibility is that Burning Rock might simply choose to privatize, which would take its messy situation out of the public spotlight while it re-engineers its business model to focus on the more promising of its two main business areas. We’ll detail that transformation shortly and why it could eventually return Burning Rock back to a healthier growth track like the 18% revenue growth it posted in 2021, a year after its Nasdaq IPO.

Such a privatization would mimic a similar move by rival Genetron Holdings (GTH.US), which announced a privatization deal last October which it expects to complete by March. Any investors with a big stomach for risk could earn a small profit by buying Burning Rock’s beaten-down shares in hopes that a similar offer is coming, since such offers usually carry premiums of 10% to 20%. But given current trends, there’s also the risk that Burning Rock’s shares could fall further still before such an offer is made, if ever.

The company’s current woes highlight a very China-specific risk tied to high levels of corruption in many Chinese sectors and potential for crackdowns. In this case, the industry is being hit by a crackdown on doctors who get healthy commissions for screening their patients for cancer using tests from Burning Rock and its peers. Such cozy relationships between doctors and medical companies aren’t unique to China, but are often more direct and lucrative for Chinese doctors who are chronically underpaid.

Things looked far different for Burning Rock when it made its Nasdaq IPO in 2020, raising about $250 million by selling its shares for $16.50 apiece. The stock initially climbed as high as $37 in early 2021, as investors got excited about the big potential for its cancer screening devices in China, valuing the company at nearly $4 billion. But the shares have moved steadily downward since then, losing about three-quarters of their value over the last 52 weeks.

Despite that, Burning Rock still has a somewhat respectable price-to-sales (P/S) ratio of 1.2, which is roughly the same as Genetron’s 1.3. But both companies trail far behind the 6.7 for Hong Kong-listed rival New Horizon Health (6606.HK), which has managed to maintain strong revenue growth despite the ongoing crackdown.

Shifting business model

Burning Rock specializes in genetic cancer testing, including screening patients for gene mutations. While other screening companies typically focus on a single form of the disease, Burning Rock has been able to detect multiple cancer types through Next-Generation Sequencing (NGS).

Such cancer-screening companies generally use two types of sales models. One involves conducting tests at hospitals and clinics, and then analyzing the results at centralized laboratories. In the other model, hospitals and testing companies like Burning Rock build laboratories together, often inside a hospital.

The centralized laboratory model is less costly and also more prone to corruption, since it relies on referrals from doctors in hospitals with no particular incentive to use a specific company’s testing products. By comparison, the second model, where companies like Burning Rock co-develop in-hospital labs, is less prone to such corruption since hospitals have a big incentive to naturally use services from their own in-house labs.

Burning Rock founder and Chairman Han Yusheng said on the company’s earnings call in November that the recent crackdown resulted in an “anomaly” that saw many medical conferences and meetings that are critical for its centralized lab testing business affected in the third quarter. But he added: “I think that this kind of volatility will pass by the end of this year.”

The volatility Han referred to resulted in a 40.6% plunge in Burning Rock’s revenue from centralized lab testing services to 53.5 million yuan ($7.54 million), according to the company’s latest financial report released in November. Its revenue from co-developed in-hospital lab testing rose about 10% for the quarter to 54.5 million yuan, passing the centralized lab testing contribution for the first time.

The company has been slashing costs to conserve its limited cash, with operating expenses down 23% during the quarter to 265 million yuan, including a 24% drop in R&D spending. While such cost-cutting is admirable and even necessary, it’s hardly encouraging for anyone who was hoping for big growth that requires aggressive spending on marketing and new product development.

The aggressive cost-cutting helped Burning Rock pare its net loss for the quarter to 175 million yuan from 232 million yuan a year earlier. Han pointed out the company’s cost cuts helped it to narrow its net cash outflow to just 47 million yuan in the third quarter – a far slower rate than the 532 million yuan net outflow for all of 2022. At that rate, the company has enough cash to fund its operations for the next three years, Han said, addressing a major investor concern.

At the end of the day, Burning Rock is a company operating in a promising sector with big growth potential, and could even sell its products outside China one day. But it’s also operating in a difficult environment due to volatility in China that’s forcing it to change its business model. Such a transformation is probably better done out of the public eye, leading to our prediction that Burning Rock might launch a privatization bid later this year. Then, the company could ultimately re-list, most likely closer to home on the domestic A-shares market or in Hong Kong, once it cleans up its house.

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